Court rules on accountant's expert testimony.

Court Rules on Accountant's Expert Testimony 

As one partner in a Big 5 accounting firm now knows, CPAs should think twice before providing expert testimony on damages in a law suit.

Using new standards to judge the acceptability of such testimony, the Seventh Circuit Court of Appeals in Chicago affirmed a district court decision that excluded the CPA's expert testimony. As a result, in Target Market Publishing, Inc. v. ADVO, Inc., the plaintiff's suit for damages was dismissed on jurisdictional grounds.

Disputed Profits Led to Suit

In 1993, Target Market Publishing, Inc. (Target), entered into a one-year contract with ADVO, Inc. (ADVO), to prepare and distribute a direct-mail advertising publication called Select Auto. The project involved selling automobile dealers exclusive advertising rights at a flat rate in the monthly publication. The two companies were to share equally any profits from the enterprise.

Whether any profits were actually earned became the primary subject of dispute. In early 1994, ADVO notified Target that it was no longer going to participate in the preparation or distribution of Select Auto.

In April 1994, Target brought suit against ADVO claiming breach of contract and breach of fiduciary duty. After the close of discovery, ADVO filed a motion for summary judgment maintaining Target could not prove its claim that it had sustained damages of at least $75,000 as a result of the failed project.

In opposing ADVO's motion for summary judgment, Target relied primarily on the report from its damages expert. The CPA's report concluded that had ADVO met its obligations under the contract Target would have earned $1.4 million in profit from the venture. ADVO maintained that the CPA's expert report was pure speculation. ADVO argued that the report was based upon implausible assumptions and unreliable methodology. The trial court concurred and granted ADVO's motion for summary judgment dismissing the case.

Daubert Set Rules for Experts

On appeal, the Seventh Circuit held that, under both Daubert v. Merrell Dow Pharmaceuticals, Inc., and General Electric Co. v. Joiner, the U.S. Supreme Court had established that a trial court should exclude expert testimony if it concludes there is too great an analytical gap between the data and the opinion offered.

In Target, both the trial court and the circuit court found that the expert's report projecting $1.4 million in profits by the end of the contract period was based upon unsupported assumptions and that the expert's testimony could not, therefore, be admitted into evidence.

In the five years since the Supreme Court's ruling in Daubert, there has been considerable legal debate as to whether that holding applied to "nonscientific" expert testimony such as the opinion of an accountant hired as a damages expert. With Target, that debate has been brought to an end.

Implications for the Profession

Thus the admissability standard set in Daubert can be a sword to the accounting profession as well as a shield.

Those defending accounting malpractice, cases may welcome the ability to use Daubert to exclude testimony offered by plaintiff's experts that is implausible and below professional standards.

As Target illustrates, however, the same arguments can be used to exclude the testimony of accountants who offer expert opinions on damages in litigation.

Other troubling possibilities exist. If a court excludes the accountant's expert opinion because it is based on implausible assumptions, the prevailing litigant could file a complaint for disciplinary action against the accountant with the state licensing board or initiate a malpractice action for the value of its claim.

(Target Market Publishing, Inc. v. ADVO, Inc., Court of Appeals, 7th Circuit, 1998)

Editor's note: Thanks to John D. Hughes of Hutchins, Wheeler and Dittmar of Boston, for this case.

--Edited by Wayne Baliga, CPA, JD, CPCU, CFE, president of Aon Technical Insurance Services.